Traders Win Important Tax Appeal

05/10/2011 3:00 pm EST

Focus: STRATEGIES

Robert Green, CPA

CEO, GreenTraderTax.com

Traders have recently won an important appeal defending trader tax status, but with the IRS and state governments still bearing down, Robert Green explains how traders can stay protected.

If you're an active trader, you may have considered getting trader tax status with the IRS. We're going to get an update on that from Robert Green of Green Trader Tax. So Robert, give us an update on how traders are faring claiming trader status with the IRS?

Good news, we just won an important appeals case that I worked on for a few years. 

The IRS has been playing the numbers game with traders. Traders usually like numbers, but not the IRS's numbers, which have been strict. They've needed 500 round-trip trades, trades four days a week.

Well it turns out that an options trader who fell below those requirements and who was audited by the IRS and denied trader tax status. 

In appeals, we got a favorable outcome because we argued that the business continuous activity test—in other words, operating your business continuously every day—counts more than the frequency of trades. 

Many options traders work every day, but they may not have an execution. So we won the case, and this is very good news for traders who feel they come up a little short on the numbers game.

So for now we're talking about time. Are we talking eight hours a day? Because I know the IRS is going to put a strict number on this. Is it six hours a day, is it the market open, and what are talking about?

We like four hours a day. Many traders spend much more than that. 

You can have a full-time job in California and trade the morning session and spend four hours a day. You can have trades on most days and put in unexecuted trades. 

So this is good news because the IRS was not giving traders credit for days they worked but did not generate a trade. They may have generated profit on an open position, but not a trade. That's the good news. 

But there's always bad news coming out of the woodwork. Arizona attacked a losing trader, saying it's a hobby loss. Our response is for Federal purposes, hobby loss rules do not apply to traders. It turns out that they inappropriately tried to de-couple from the Federal government, and they cannot. 

Most states follow the Federal rules. It's not a hobby loss. Trading is not a personal activity, it's not recreational.  It is for the purpose of making money, and people want to make a livelihood, it does not have to be their principal livelihood. 

So the good news is that you can defend your trader tax status in a strong way at this juncture. 

The bad news is that the IRS and states are hungry for money, and they see traders as an ideal target. The missing link is a solid firm to defend you.
 
In this Arizona case, the bill was $400. The client was not going to fight it. That's where our Traders Association stepped in for free to defend this trader, because we will not let one state or one jurisdiction attack traders, as that could serve as negative precedent for all traders.

All right, so if before, we just kept track of our trades for the numbers, how do we then prove our time to the IRS?

Well, we don't have punch cards, but traders can keep cache of their log-in sessions at brokers. They can keep a record of when they're logged into the platform. They can keep a diary, an online diary. They can send themselves daily e-mails.

I have found on exams that traders really impress the IRS with the amount of work that they do. We all know in this industry, traders do their homework and they spend a lot of time. 

So if we can just get credit for the time and not have to rely just on the trades, that will serve as a great advance for trader tax status.

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